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SLI UK Real Estate Fund Quarterly Update - Q2 2019

Past performance is not a guide to the future. This information is for professional clients and investment professionals only and should not be relied upon by retail investors.

The SLI UK Real Estate Fund quarterly update provides an overview of the market; fund performance, positioning and portfolio changes; and the fund manager’s outlook for the months ahead.

Economic overview and property market• The UK economy continues to be weighed down by

macroeconomic uncertainty, although GDP did tick up very marginally from 0.2% quarter-on-quarter in Q4 2018 to 0.5% in Q1 2019. However, inventory building was key to this. Companies stockpiled resources ahead of anticipated disruption to supply chains that would have been caused by a cliff-edge withdrawal from the European Union (EU) on 29th March 2019. With the Brexit deadline now extended to end-October, macroeconomic uncertainty looks likely to persist in the near term, holding back growth. The ASI Research Institute has revised its expectations for GDP growth downwards to 1.4% in both 2019 and 2020. In spite of a relatively tight labour market, accommodative monetary policy and high corporate profit margins, inflation remains stubbornly low. Although the Bank of England has given hawkish signals, we expect interest rates to remain lower for longer if they are to support the deteriorating growth backdrop – particularly until greater clarity emerges on the UK’s future relationship with the EU.

• Overall, occupier markets are holding up relatively well given the ongoing uncertainty facing UK businesses. Take-up in the office sector remains robust, while central London take-up has recovered following a muted period around the EU referendum and is now back close to the high watermark set in 2015. However, this is largely driven by flexible office providers; traditional take-up

has been flat-lining since early 2016. It’s important to note that the now 20% of take-up by those providers does not actually absorb supply, as it must all be re-let into the market and, importantly, at higher densities of occupation. Regionally, headline rents are steadily rising in the big six office markets, boosted by the trend towards consolidation among some of the largest corporate occupiers, as well as the public sector’s shift towards large regional hubs. While supply is generally not an issue, the economic backdrop is expected to affect demand and, therefore, rents going forward.

• The second quarter has seen a steep fall in transaction activity to levels not seen since the Eurozone crisis of 2012. Less than £6.5 billion of deals were done in Q2, despite Citigroup’s £1.1 billion purchase of its Canary Wharf headquarters. Indeed, there were fewer office deals than in any quarter since the global financial crisis and overseas investors were net sellers in the UK market for the first time in over 10 years. Chinese capital controls appear to now be having a significant effect on global real estate markets. Although New York has perhaps borne the brunt of Chinese disinvestment, London is not immune. With concerns emerging that Korean asset managers may be struggling to re-sell equity in big overseas deals, it is not clear that current pricing can be supported. The retail sector, however, is significantly more distressed, with the shallow pool of buyers tending to be opportunistic in nature and a glut of stock being quietly marketed. The raft of CVAs (company voluntary agreements), and uncertainty about where rental values will settle mean investors are demanding huge discounts to valuation. The listed market and secondary pricing of unlisted funds gives a clear indication of the required discounts to prevailing valuations to price in the risk.

• Investment appetite from UK institutional investors remains heavily skewed towards the industrial and alternative sectors. A more subdued UK real estate investment market in the first half of 2019 has made acquiring assets in these sectors more challenging, particularly as investors are reluctant to dispose of assets in these more favoured sectors. Significant weight of capital targeting long-duration secure income is supporting pricing at levels which is out of reach for most balanced funds. However, it remains supportive for liability-driven investors where inflation-linked income in other assets classes does not match the required income yield. The UK build-to-rent (BTR) sector continues to attract significant levels of interest from both international and domestic capital. The market fundamentals for this sector are compelling, and the clear structural imbalance between supply and demand is being compounded by more punitive government policies directed at smaller-scale buy-to-let landlords. A recent survey by the Residential Landlords Association found that one in four private landlords is looking to sell at least one property over the next year. If that stock is lost to the rental market, institutional investors can play an important role in filling this void. Durable income will remain the key focus for investors in the current risk-off environment. It is highly unlikely that there will be any material change to the investment themes playing out in UK real estate until more clarity is provided on the macroeconomic outlook.

Investor outlook for UK industrials remains positive, whilst weaker sentiment towards the retail sector continues to negatively impact capital value expectations

Source: DataStream, RICS, Aberdeen Standard Investments, July 19

UK Real Estate Investment Levels by Sector

Q1

2009

Q1

2010

Q1

2011

Q1

2012

Q1

2013

Q1

2014

Q1

2015

Q1

2016

Q1

2017

Q1

2018

Q1

2019

100

80

60

40

20

0

-20

-40

-60

-80

-100

Capi

tal V

alue

Exp

ecta

tions

(Net

Bal

ance

%)

Industrials Offices Retail

RICS survey - capital value expectations

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Top 10 holdings % Direct Property

Leamington Shopping Park, Leamington Spa 4.9Monument Mall, Newcastle Upon Tyne 4.0The Old Dairy, South Ruislip 3.8Isis Reach, Belvedere 3.845 Church Street, Birmingham 3.7Io Centre & Tradeway, Sutton 3.6The Gateway Retail Park, Beckton 3.4Masthead Industrial Estate, Dartford 2.6Solar Park, Birmingham 2.5Saxon Way Trading Estate, Heathrow 2.4Source: Aberdeen Standard Investments, 30 June 2019. Figures ex Cash.

Top 10 tenants % Contracted Rent

B&Q & Screwfix 3.8Office Depot International 3.1Tesco 2.5Asda 2.4Sainsburys & Argos 2.2Weatherford U.K. Limited 2.2UK Insurance Limited 1.9T P Bennett LLP 1.7TBWA UK Group Limited 1.7Marks & Spencer 1.6Source: Aberdeen Standard Investments, 30 June 2019. Figures ex Cash.

Fund size £2,085.1mAverage lot size £23.4mAverage lease length 7.7 yearsNumber of properties 68Number of tenancies 523Historic yield 3.42%*Net current assets 23.7%^Vacancy rate 8.4%

Source: Aberdeen Standard Investments, 30 June 2019*Yield at 30/06/19. Yields are historic based on the preceding 12 months’ distributions as a percentage of the midmarket unit/share price at date shown. Yields will vary, do not include any preliminary charges, and investors may be subject to tax on distributions. Based on institutional income shareclass.^ The Net Current Assets figure includes cash or cash equivalents and any short term assets and liabilities within the fund.

Lease expiry profile % Contracted Rent

Less than 5 years 54.3Between 5 and 10 years 25.7Between 10 and 15 years 8.4More than 15 years 11.5

Sector allocation

Source: Aberdeen Standard Investments, 30 June 2019. Figures ex Cash.

Geographical breakdown

Source: Aberdeen Standard Investments, 30 June 2019. Figures ex Cash.

Industrial SERetail W/house

Industrial Rest of UKOffices Rest of UK

Std Retail SEOffices Rest of SE

Std Retail Rest of UKOther

Offices West End/Mid TownShopping Centres

%

14.2

0 5 10 15 20 25

23.6

12.510.5

6.96.8

5.44.2

2.8

13.1

%

Rest of LondonSouth East

West MidlandsNorth West & Merseyside

North EastScotland

London West EndSouth West

EasternEast Midlands

WalesYorkshire and Humberside

0 5 10 15 20 25 30

24.923.3

13.49.0

7.16.8

4.23.22.82.7

1.41.2

Fund positioning

Fund facts

Performance - % growth3 mths 6 mths 1 yr 3 yrs* 5 yrs*

SLI UK Real Estate Fund -0.5 -0.4 1.4 4.5 3.7IA UK Direct Property -0.1 0.0 0.3 4.1 4.4

Source: Aberdeen Standard Investments, 30 June 2019Data to end June, Fund performance net of Platform 1 fees.*Returns are annualised

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Portfolio update Transaction and Asset Management ActivityDuring the period the Fund disposed of East Kilbride Retail Park, East Kilbride (£12.25m); Stock Exchange Court, Buchanan Street, Glasgow (£33.0m) and Castlemore Retail Park, Manchester (£11.7m) in the Retail sector. In the Office sector, the disposal of One Eton Street, Richmond (£34.5m) and 28-30 Cornhill, London (32.0m) also completed. As at 30th June 2019 the NCA as a % of NAV in the Fund was 23.7%.

Ongoing asset management activity surrounding the existing portfolio remains a key focus as we seek to implement initiatives aimed at income and value enhancement.

In the Retail sector, activity continued with a number of transactions taking place. At Link Retail Park, Thanet, a lease renewal with Hobbycraft secured an additional 10 year term at a rent of £151,300 per annum and a lease renewal with Mountain Warehouse completed providing an additional 10 year term at a rent of £66,400 per annum. At Bligh’s Meadow, Sevenoaks, a new letting to Whistles secured a 10 year term at a rent of £65,000 per annum. At Monument Mall, Newcastle, a rent review completed with Reiss, generating an uplift in rent to £169,222 per annum (an increase of 12.8%).

In the Office sector at Annandale House, Sunbury, the Fund completed a rent review with British Telecommunications documenting a revised rent of £838,245 per annum (£11.75 psf), an uplift of 8.86%. At Central Square South, Newcastle, a new lease completed with Sanderson Weatherall providing a 10 year term at an initial rent of £101,982 per annum (£23.75 per sq ft) alongside a new lease to DHF securing a 10 year term at an initial rent of £67,680 per annum (£24.25 per sq ft). At 1 Marsden Street, Manchester, Calvin Capital have entered into a new 10 year lease at an initial rent of £199,512 per annum (£32.00 per sq ft) alongside restructuring their existing lease over the 5th floor to provide a further 3.5 years term. At 45 Church Street, Birmingham, the Fund completed a new lease to Gerald Eve to secure a new 10 year term at a rent of £93,957 (£32.50 per sq ft) and a new lease to Ascott Lloyd to secure a 5 year term at an initial rent of £137,460 (£30.00 per sq ft).

In the Industrial sector, at Omega Park, Didcot, a reversionary lease to Pirelli Motorsport Services completed adding a further 4 years of term at a rent of £407,160 per annum (£7.50 per sq ft), an increase of 8.5%. At Sutton Trade Park, Sutton, a lease renewal with Angel Plastics secured an additional 5 year term at a rent of £72,000 per annum (£15.95 per sq ft) and a rent review with Euro Car Parts documented a rent of £83,500 per annum (£11.75 per sq ft), an increase of 106% from the previous passing rent.

Property in focus Asset Disposal East Kilbride Retail Park, East Kilbride

• 59,400 sq. ft. retail warehouse asset outside South of Glasgow

• Sold for £12.25m

Lease Renewals 45 Church Street, Birmingham

• Prime Birmingham business district office asset extending to 13 floors

• Revised 10 year lease with Gerald Eve at £93,957 pa. Also an additional 5 year term agreed with Ascott Lloyd at £137,460 pa.

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Performance reviewThe Fund underperformed the IA UK Direct Property Sector for Q2 2019 recording a Total Return of -0.53% against the sector of -0.05%. The Fund has outperformed this sector over 1 and 3 year periods. The Fund’s industrial assets continued to provide the strongest returns in line with the market. The retail sector as a whole however is providing a drag on performance as the sector addresses structural changes.

Forecasts & outlook• Returns from UK commercial real estate continued to slow over

the period. Industrial and long income type sectors continue to generate the strongest returns while the retail sector continued to weaken with capital and rental value growth trending negative.

• We believe that UK property continues to provide a supportive role as part of a balanced portfolio although the returns from the UK commercial real estate market are expected to continue to moderate. Given the backdrop of continuing heightened macro uncertainty, however, we expect to see more polarised performance between prime and secondary assets and across the sectors. Asset specifics are key however the Fund maintains a focus toward prime / core assets and an overweight exposure to the favoured industrial sector.

• We will continue to implement asset management initiatives across the portfolio aimed towards maintaining income and capital preservation.

(*1) Source: Standard Life Investments/Morningstar. Fund returns net of Platform 1 fees.

UK Sector Outlook Q2 2019 - 3 Year ViewLondon Standard IndustrialRest of SE Standard IndustrialLondon Distribution WarehousesRest of SE Distribution WarehousesBuild to Rent (Rest of UK)HealthcareRest of UK Standard IndustrialHotelsBuild to Rent (London)Student HallsSupermarketsEdinburgh OfficesRest of UK Distribution WarehousesBristol OfficesManchester OfficesLeeds OfficesBirmingham OfficesGlasgow OfficesALL PROPERTYRest of UK OfficesInner London OfficesLeisureRest of London ShopsSolus Retail WarehousesRest of SE OfficesCentral London ShopsMid Town OfficesWest End OfficesDominant Standard ShopsCity OfficesRetail ParksDominant Regional Shopping CentresOther Standard ShopsOther Shopping CentresSource: Aberdeen Standard Investments, 30 June 2019

8.2%

-6.3%

0.8%

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Risk profileInvestors should be aware of the following risk factors:

• (a) Commercial property is less liquid than other asset classes such as bonds or equities. Selling property can be a lengthy process so investors in the fund should be aware that they may not be able to sell their investment when they want to.

• (b) Commercial property transaction charges are higher than those which apply in other asset classes. Investors should be aware that a high volume of transactions would have a material impact on fund returns.

• (c) Property valuation is a matter of judgement by an independent valuer and is therefore a matter of the valuer’s opinion rather than fact.

• (d) The use of derivatives carries the risk of reduced liquidity, substantial loss and increased volatility in adverse market conditions, such as a failure amongst market participants. The use of derivatives may result in the fund being leveraged (where market exposure and thus the potential for loss by the fund exceeds the amount it has invested) and in these market conditions the effect of leverage will be to magnify losses. The fund does not make extensive use of derivatives.

The fund employs a single swinging pricing methodology to protect against the dilution impact of transaction costs. A change in the pricing basis will result in movement in the fund’s published price. All investment involves risk. This fund offers no guarantee against loss or that the fund’s objective will be attained.

Past performance is not a guide to future returns and future returns are not guaranteed. The price of assets and the income from them may go down as well as up and cannot be guaranteed; an investor may receive back less than their original investment.

Inflation reduces the buying power of your investment and income. The value of assets held in the fund may rise and fall as a result of exchange rate fluctuations.

The fund could lose money if an entity (counterparty) with which it does business becomes unwilling or unable to honour its obligations to the fund.

In extreme market conditions some securities may become hard to value or sell at a desired price. This could affect the fund’s ability to meet redemptions in a timely manner.

The fund could lose money as the result of a failure or delay in operational processes and systems including but not limited to third party providers failing or going into administration.

Annual returns to 30 June 2019 (%)2019 2018 2017 2016 2015

SLI UK Real Estate Fund 1.4 6.9 5.3 -4.2 9.3

Source: Aberdeen Standard Investments, 30 June 2019Fund returns net of Platform 1 fees.

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Aberdeen Standard Investments has not considered the suitability of investment against your individual needs and risk tolerance. If you are in any doubt as to whether this fund is suitable for you, you should seek advice. An advisor is likely to charge for advice. We are unable to provide investment advice.

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GB-310719-95899-1